My new investment property with 15% expected annual return

Owning a piece of the suburb

The recent stock market mayhem is a crucial reminder of how important it is to maintain a well diversified portfolio. After selling my farm last year I was too overweight in stocks so I decided to rebalance. 😉 At the beginning of this year I welcomed a new investment property into my growing portfolio. 🙂 It’s a one bedroom apartment in a low-rise building – less than 10 years old. It features an open floor plan that measures about 650 sf, and has a large balcony.

In today’s post I will explain why this purchase makes financial sense for me, and break down the numbers.

Why invest in Vancouver real estate? 

In a previous post I explained how to improve investment returns by primarily focusing on broad asset class trends instead of analyzing individual assets. In late 2019 I was trying to find the most undervalued asset class. At the time, stocks were at record highs. The expected return for the TSX index was just 5% a year. Likewise bond yields were a joke – and still is today. So nothing looked attractive. 🙁 I was starting to lose hope.

But then I looked at the real estate market. To my surprise the expected return was 10% or higher. Hey, now we’re getting somewhere. 😀 I have discovered an undervalued asset class with terrific return potential. Ka-ching!

The next step was figuring out where to buy real estate. For tax purposes I planned to stay within Canada. I also wanted to buy in a large city with steady population growth. After looking at Montreal and Toronto I ultimately decided to stay around Vancouver due to the following reasons.

• Prices in Vancouver recently pulled back about 12% from all time highs in 2018.
• The capitalization rate has greatly improved over previous years.
• Insanely low vacancy rate of just 1% helps keep rental rates high.
• Relatively high population growth.
• Home city advantage. I can manage the investment myself instead of paying a property manager.

Choosing the right investment property

The last step was to narrow down my choices by making a list of criteria – such as the price range, rental restrictions, building age, capitalization rate, etc. The capitalization rate is a measurement of profitability. It’s the net income generated from the property divided by the property’s price. A good cap rate in Vancouver is 3.5% or higher.

A couple of years ago Vancouver was a terrible place to buy rental properties because the projected returns were abysmal. According to Colliers International, the cap rate here was as low as 2%. Ouch. Here’s the data for Q1 2018.

However, things turned around over the next 2 years. By the end of 2019 the cap rate climbed as high as 4.25% in some segments of the market. 🙂 It’s still not as lucrative as in other cities, but it’s comparatively better than before. Here’s the data for Q4 2019.

At this point I knew exactly what I’m looking for. So I was finally ready to head out and find me some prime real estate. 🙂

I started searching in October on the website zealty.ca. I also hired a realtor to help me filter listings and write offers. By the way, if you’re looking to buy or sell I recommend finding yourself a British real estate agent. They’re all about the proper-tea. 😀

Anyway, in the beginning all my offers were falling through. Then one day in December I came across a very promising condo in Burnaby, a vibrant city east of Vancouver.

I attended the open house and liked the property right away. It satisfied about 90% of my buying criteria which was excellent. 🙂 The asking price was also reasonable. The market was heating up so I knew I had to act fast. I made an offer shortly after viewing the place. After some back and forth an agreement was reached, and I paid a small deposit – or as I like to say, a condo-minimum. 😀 I removed my conditions after getting a home inspection and mortgage confirmation. A few weeks later the property was mine. 🙂

Rental Property Criteria

So here are the reasons why I like this condo.

• Low strata (HOA) fee which works out to just $0.28 per square feet.  (See fee schedule here)
• High cap rate of 3.6% to 4.0% range according to comparable rents in the area.
• Built by a reputable developer.
• High walk score and transit score – over 80% for both. This makes it easier to find renters.
• Safe neighborhood, with a relatively young demographic.
• Area has a high level of education and high median household income (~$110,000 according to StatCan.)
• Unit not facing south or west so it doesn’t become a sauna in the summer.
• No upcoming special assessments or deficiencies in the building.
• Friendly neighbors.

Now here are some things I don’t like the about property.

• The underground parking spot is a bit far from the elevator.
• Can be a little noisy due to construction down the street.

So there’s not much to complain about. Overall I’m very happy with this purchase. 🙂

In any case it was finally time to make some money from my new investment. Do you know how many ants you’ll need to fill an apartment? The answer is tenants. 😀 I showed the apartment to more than a dozen potential tenants. There were a few goofballs who didn’t show up to their appointments.

But eventually I found a young, middle class couple with a cat. One of them (not the cat) has a credit score in the high 700s, – surprisingly good for someone in his mid 20s. They moved in at the end of February and pay a monthly rent of $1800 – which they can easily afford on their combined gross income of $100,000/year.

This puts my rental unit’s cap rate at 3.9% – which is on the high side for a Vancouver area condo according to the Colliers table shown above. 🙂

Breaking down the numbers

From the beginning I wanted an investment property that would be cash flow positive. A conventional 20% down payment wouldn’t cut it. So instead, I decided to proceed with a 30% down payment.

Total purchase price $450,000
-Down payment $135,000 (30%)
-Mortgage $315,000  (70%)

By the way, anyone can pull up the historical records of BC condo sales online. By knowing the exact purchase price it would be easy to find out my property’s address. So for privacy reasons I’m using $450,000 as a ballpark figure, which is very close to the actual price I paid.

The interest rate on my $315,000 mortgage is 2.44%. I went through a mortgage broker instead of a traditional lender to get the best rate. My mortgage payment is about $1400 a month. 🙂

Monthly Cash flow Statement

Money coming in:
Rent = $1800
Total income: $1800

Money going out:
Mortgage = $1400
Strata fee = $185
Property tax = $120
Homeowner insurance = $35
Total expenses: $1740

Monthly Cash flow = +$60

Woot! Every month my tenants are covering my complete mortgage payment, helping me build equity, and I have $60 to spare. This is such a sweet deal for me. 😀 Why didn’t I become a landlord sooner? lol.

Operating profit

In order to determine how profitable this investment is we can calculate my property’s return from operations.

Return = Net gain / Cost of investment

Net gain: refers to my profit after subtracting any realized costs to manage the property.
These costs would be:
-Mortgage interest = $640
-Strata fee $185
-Property tax $120
-Insurance $35
-General wear/tear and long term maintenance $70
-Total expected costs = $1,050 

My rental income is $1,800 a month. So my net gain from operations is ($1,800-1,050) or $750 a month or $9,000/year.

Cost of investment: refers to the initial money I put into this property. This includes the $135,000 down payment, the $7,000 property transfer tax, and $2,000 of lawyer and admin fees. This all adds up to $144,000.

So my return from operations = $9,000 / $144,000 = 6.25% 🙂

I know 6.25% before tax is not a particularly exciting return. However, I’m counting on price appreciation as well. After all, my farmland was operating at a loss year after year, but in the end I still made 20% annualized return on investment.

Total Return on Investment

Much like my farmland, I plan to hold my rental condo for at least 7 to 10 years. I don’t know what real estate prices will do in the future. But I can make some educated assumptions based on historical data and economic trends.

Greater Vancouver condo prices have increased on average by 5.6% annually over the last 10 years according to the region’s Real Estate Board. I believe immigration, foreign investment, and a strong labor market were the main contributors to the increase in housing demand since 2010. I am speculating here. But since these economic drivers don’t seem to be going away any time soon, it shouldn’t be a surprise if the 5.6% annual growth rate continues for the next 10 years. But since I want to be conservative with my estimate, half of the historic growth rate, or 2.8% seems like a reasonable assumption to make. 🙂

2.8% of the $450,000 purchase price is $12,600. If we combine this together with the previously calculated $9,000 operating income, the total gain becomes $21,600. Which brings my total ROI to $21,600 / $144,000.

Total expected ROI = 15%.

There’s a famous aphorism from Warren Buffett about the mindset of a sensible investor: Rule #1: Don’t lose money. Rule #2: Don’t forget rule #1. My favorite aspect of this real estate investment is that there’s almost no way I could lose money on it. Even if there was zero capital appreciation I would still be happy collecting the 6.25% annual return from the rental income alone. 😀

I was lucky to find such a profitable rental unit with a 3.9% cap rate in a growing neighborhood. If all goes according to plan, this investment property will boost my net worth by $21,600/year going forward. 🙂 Simply amazing! I should celebrate and take a vacation. I hear cruises are dirt cheap these days. 😉

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Random Useless Fact

British people like to eat beans and toast.